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Transcript of 2010 as 30 - Financial Instruments - Wirc
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AS 30 Accounting of
Financial Instruments
1
Presentation at WIRC Seminar
By Jayesh Gandhi May 29, 2010
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Why an AS for Financial Instruments ?
At present, no Comprehensive standard in Indian GAAP
AS 11 deals with foreign currency transactionsincluding derivatives.
AS 13 deals with all investments, including property.
2
AS 16 deals with accounting of borrowing cost and
element of cost.
Diverse accounting practices followed have made
comparability of performance difficult.
Due to non disclosure, effect of derivatives were hidden
in the financial statements and huge impact was known
only on expiry / cancellation.
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AS 30 Applicability
Comes in effect for accounting periods beginning on or
after April 1, 2011 Early adoption is permissible. However, it can not be
done in parts.
3
Early adoption for derivative accounting mandated bythe institute as per circular of March, 2009, to the extent
of loss.
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Scope applies to all Financial instruments
except:
Interest in Subsidiaries, Associates and Joint Ventures covered by AS
21, 23 & 27 except as mentioned in those standard;
Lease transaction covered by AS 19. However lease receivables,payables & derivatives embedded in lease will be covered by this
standard;
Insurance Contracts. However financial guarantee contracts and
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derivatives embedded in insurance contract covered by this standard;
Contingent consideration for the acquirer or business combinations to
buy or sell at a future date;
Loan commitments, other than specific inclusions when held for sale;
Share based payments (incl ESOPs) and Employers rights and
obligations under AS 15;
Own use commodity contracts other than those which are generally
settled net in cash MCX, NCDEX transactions, which at present cannot
get settled through delivery ?
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Items are scoped out of the standard if another standard is more prescriptive
in dealing with such items.
From the date of the applicability of this standard following will be withdrawn:
- AS 13 on Accounting for Investment except for portion pertaining to
Investment properties
Scope applies to all Financial instruments
except: (contd.)
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- on e e ec o c anges n ore gn xc ange a es o e
extent it covers forward exchange contracts
- AS 4 on Contingencies and Event Occurring After the Balance Sheet
Date to the extent it covers contingencies
- Guidance Notes on:
(i) Guarantees and counter Guarantees given by companies
(ii) Accounting for Investment in the Financial Statements of Mutual
Fund
(iii) Accounting for Securitisation
(iv) Accounting for Equity Index & Equity Stock Futures and Options
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Available-for-sale financial assets -
accountingAll available for sale assets are marked to market through a separate
component of equity (Investment revaluation reserve account)
Gains and losses on AFS assets are recognised in the profit and lossaccount on disposal or impairment of the asset. However, there are a
number of other complications with available for sale gains and losses
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a n or oss on ava a e- or-sa e asse
Effective interest
rate
Other changes in
fair value
Change in value
due to spot FX
change
Change in value
due to embedded
derivative
EquityProfit and Loss Account
Recycled to the profit and
loss account on disposal or
impairment of the asset
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Amortised cost and effective interest
method
Initial
Recognition
Amortised
cost
Cumulativeamortisation
usingeffectiveinterestmethod
impairment
/un-collectibility
PrincipalRepayments= /+
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Effective Interest Method - Method of calculating amortisation cost andof allocating interest Income / Expenses over the relevant period
At each reporting date apply the effective interest rate to carrying
amount to determine interest income and interest expense
Effective Interest Rate Rate that exactly discounts estimated future
cash payments and receipts through the expected life of the financial
instrument
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Calculating amortised cost - Example
Treasury note with face value Rs. 100,000, 5 year
maturity, 6% coupon rate
Purchase price Rs. 95,900
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scoun s. ,
IRR (i.e. effective rate) is 7%
Note : Any expenditure incurred for raising finance can
also be considered in the working of IRR.
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Calculating amortised cost - Example
Year BB
Effective
interest Coupon
Discount
amortisation EB
a b=a*7% c=100000*6% d=b-c e=a+d
1 95,900 6,713 6,000 713 96,613
2 96,613 6,763 6,000 763 97,376
3 97,376 6,816 6,000 816 98,192
4 98,192 6,873 6,000 873 99,065
5 99,065 6,935 6,000 935 100,000
Total 34,100 30,000 4,100
9Note : Over the period Rs. 4100 get adjusted.
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Classification determines subsequent
measurement of financial assets
At fair valuethrough P&L
Yes
Classified as held fortrading or designated
as at fair valuethrough P&L at
inception
No (A
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Available-for-saleNo
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financial assets,fixed/determinable
payments, not quotedin active market
Intent and ability tohold to maturityand meets other
criteria
Yes
Yes
No
Loans andreceivables
Held-to-maturity
Fairvalue o
rtised)cost
similarly applies to financial liabilities
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Initial Recognition
Initial Recognition of a FA or FL to be done by an entity
when, and only when it becomes a party to thecontractual provisions of the instrument
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con rac ua r g s o ga ons un er er va ves are o erecognized on balance sheet as asset or liability except:-
If a transfer does not qualify for derecognition then
Transferor does not recognize derivatives of the FA / FL separately
Transferee does not recognize transferred FA / FL as its FA / FL
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Initial RecognitionRecognize assets to be acquired or liabilities to be incurred as
a result of firm commitment to purchase or sell goods or
services only when
At least one of the parties has performed under the agreement or
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But in case of an unrecognized firm commitment that is designated as
hedged item in a fair value hedge, any change in net fair value attributable
to hedged risk is recognized as asset or liability after inception of hedge
Dont recognize FA/FL arising out of planned future
transactions no matter how likely, as entity is not party to
the contract
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At fair value + / - directly
Other FA / FL
FA / FL @ FVTPL
Short-term receivables /
payables with no stated interest
rate
Initial Measurement
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attributable transaction cost
date ofacquisition or
issue
if effect of discounting isimmaterial
If settlement date accounting is used for an asset that is subsequently
measured at cost or amortized cost, then it is initially recognized at FV on
the trade date
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Fair value (FV) An amount for which an asset could be exchanged, or liability
settled, between knowledgeable, willing parties in an arms length
transactionPresumption of FV
Entity is a going concern, without
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e n en on or nee o qu a e or
curtail materially the scale of operations or
to undertake a transaction on adverse terms
FV is not the amount that would be received or paid in
a forced transaction, involuntary liquidation or
distress sale
FV reflects credit quality of financial instrument
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Fair Value
Normally transaction price at initial recognition
Use valuation techniques if part consideration is forsomething other than the financial instrument
FV of non-market interest bearin lon term loan or
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receivable can be estimated to be PV of future cash flows discounted at prevailing market rates for
similar instrument with similar credit rating
Additional amount lent is an expense or reduction of income unlessit qualifies for recognition as some other type of an asset
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Fair Value
Amount lent at below market rate and up-front fee received
as compensation Loan initially recognized as asset at its FV i.e. net of the
fee received
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Discount accreted to the profit & loss using effectiveinterest rate method
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Transaction Costs (TC)
TC = Incremental cost directly attributable to
acquisition, issue or disposal of FA or FL
Increment cost = cost that would not have been incurred if
the entity had not acquired, issued or disposed off the
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financial instrument
For FA TC are added to amount originally recognized
For FL TC are deducted from amount of debt originally
recognized
TC expected to be incurred on transfer or disposal of a FI
are not included in its measurement
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Transaction Costs
TC not considered in fair value measurement at initial
recognition FI @ FV through PL
Short term receivables & payables
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TC included in calculation of amortized cost using effectiveinterest rate method and thus amortized through P & L over
life of instrument
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Transaction Costs
For FA-AFS,
TC are recognized in appropriate equity account as part of change in
FV at next measurement
If AFS has fixed and determinable payments and does not
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TC amortized through PL using effective interest method
If AFS does not have fixed and determinable payments and
has indefinite life then
TC recognized in PL when FA is derecognized or becomes impaired
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Subsequent Measurement of FA
Amortized Cost
using effectiveinterest method
HTM Investments
FV without
deductingtransactions costs
that maybe
incurred on sale or
FA @ FVTPL
Amortized Cost using
effective interestmethod except for
short-term
receivables that are
carried at original
Loans &
Receivables
FV without
deductingtransactions costs
that maybe incurred
on sale or disposal
Available for Sale
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Test for
impairment to be
performed
Test for impairment
to be performed
Test for
impairment to be
performed
No test for
impairment to be
performed
Unquoted Equity instruments whose fair value cannot be reliably measured and derivatives linked
to such equity instruments measured at cost
For FA measured at FV and the FV is negative, then it is a FL
Hedged FA items to follow hedge accounting requirements
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Subsequent Measurement of FL
At amortized cost using effective interest method except
FL at FVTPL unless
Derivative liability linked to an unquoted equity instrument whose
FV cannot be determined measured at cost
FL arising out of transfer of FA not qualifying for de-recognition
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Recognize obligations retained by the entity Short-term payables at original invoice amount
Financial Guarantee Contract & Commitments to provide Loans
below Market Interest Rate, higher of
Amount determined as per AS 29 and
Amount initially recognized
Hedged FL items to follow hedge accounting requirements
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Regular Way Purchase or Sale of a Financial Asset
Trade Date Accounting : The trade date is the date that an entity commitsitself to purchase or sell an asset.
Settlement Date Accounting : The settlement date is the date on which an
asset is delivered to or by an entity.
Trade Date / Settlement Date
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There is no bar in applying Trade Date Accounting for certain category ofFinancial Asset and Settlement Date Accounting for another category !!
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ReclassificationsAt fair value through profit or loss category
No reclassification of a financial instrument either into or
out of this category is permissibleHeld-to-maturity investments category
If, as a result of a change in intention or ability, it is no
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maturity or if because of sales or reclassification of morethan an insignificant amount of held-to-maturity
investments, no investment can be carried under this
category: Reclassify the investment as available for sale
Remeasure it at fair value
Recognise the difference between its carrying amount and the fair value
in the appropriate equity account (Investment Revaluation Reserve
Account).
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Reclassifications
From Available-for-sale category to HTM category
If as a result of a change in intention or ability; or becausethe two year condition has ended, etc., and it becomesappropriate to carry an investment as held-to-maturity and
measure it at amortised cost:
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the fair value on that date becomes its new cost.
Any previous gain or loss recognised directly in the appropriate
equity account:
Is amortised over the remaining life of the investment using the
effective interest rate method.
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Gains & Losses on changes in FV
FA / FL @ FVTPL
Recognized in P & L
AFS FA Appropriate Equity Account (Investment Revaluation Reserve) except
Impairment losses & Foreign Exchange Gains & Losses to P & L
When FA is derecognized, balance in this equity account is transferred
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to P & L
FA / FL @ Amortized Cost
Recognized in P & L
Hedged items to follow Hedge Accounting requirements
In case of settlement date accounting
Change in FV between trade date & settlement date is not recognized if
the FA / FL is carried at cost
Otherwise it is taken to P & L or the Appropriate Equity Account
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Objective evidence of impairment
Evidence of impairment
Significant financial difficulty of the issuer
At each balance sheet date, the entity should assess
whether there is objective evidence of impairment for an
asset or group of financial assets
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Default or breach of contract
Granting of a concession by the lender due to the borrowers financial position
Bankruptcy or financial reorganisation of the borrower
Disappearance of an active market for the assets concerned because of financial
difficulties
Significant or prolonged decline in market price in the case of an equity security
Observable data that there is a measurable decrease in the estimated future cash
flows for a group of financial assets
Adverse changes in the payment status of borrowers in the group
National or local economic conditions that correlate with defaults on assets in the group
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Available for sale assets recognizing
impairment lossesSituation A: asset with gains recordedin equity
Situation B: asset with losses recordedin equity
Reversal ofpreviousupward fairvalueadjustment
Write down
Fair
value inequity
Fair
value inequity
(a)
Transfer fairvalue writedown to P&L
nowimpairment
Fair valuewrite down
previously
recognized
in equity
(c)
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= fair value
P&L
Recoverableamount
Cost
Periodx
Periodx+1
Periodx+2
Recognizeimpairment inP&L
Recoverableamount
(d)
Periodx
Periodx+1
Periodx+2
(a) Equity Dr. (c) P & L Dr.
To Asset To Equity
(b) P & L Dr. (d) P & L Dr.
To Asset To Asset
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DerecognitionDerecognitionRemoval of a previously recognised Financial Asset (FA)
or Financial Liability (FL) from an entitys balance sheet
Derecognition of a FA is on transfer of associated risks and rewardswhilst that of a FL is on extinguishment of obligation
A transaction is treated as a transfer of FA if all three criteria
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An entity has no obligation to pay amounts to the transferee unless it
collects equivalent amounts from the original asset;
An entity is prohibited from selling or pledging the original asset; and
An entity has an obligation to remit any cash flows it collects on
behalf of the eventual recipients without material delay.
Derecognition can be applied to a part of FA / FL or a
part of a group of similar FA / FL
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Main concepts of derecognition principles
Continued
recognition
Assets remain on
the balance sheet of
the transferor
Derecognise
Assets qualify for
de-recognition and
Yes
Has the entity transferred its rights to
receive the cash flows from the asset?
Has the entity assumed an obligation topay the cash flows from the asset thatmeets the conditions in paragraph 18?
Yes
Have the rights to the cash flows fromthe asset expired?
No
No
No
Yes
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removal from the
balance sheet
risks and
rewards
of ownership of
financial assets
Yes
Has the entity retained substantially allrisks & rewards?
Continue to recognise the asset to the extent of the entitys continuing involvement
Analysis of
control offinancial assets
Yes
No
Has the entity retained control of the
assets?
Has the entity transferred substantially
all risks and rewards?
No
No
If the entity retains the right to service the FA for a fee it should recognise a service
asset or liability for that service contract
Yes
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Derivatives accounting rules
All derivatives are always marked-to-market (MTM) with changes infair value recognised in the P&L (unless used as hedging instruments
in cash flow hedge in which case, fair value changes are transferred toreserves) except for:
Regular way purchase or sale of aContracts for normal purchases and
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Delivery within a time frame established
by regulation or convention in the
market
Apply trade date or settlement date
accounting
If the contract permits net settlement of
the change in the value, such contract
is accounted as a derivatives in the
period from trade date to settlement
date.
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Intended to meet purchase, sale or
usage requirements
Designated for that purpose
Will be settled by delivery
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Embedded derivatives
How to identify?
An implicit or explicit term in a contract
that makes it behave like a derivative
Instruments with conversion features
Transactions in third currency
When to separate?
The embedded derivative is not
closely related to economiccharacteristics and risks of the host
(e.g. leverage, optionality feature);
Embedded derivative would be a
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Instruments with option to extend the term
of debt
Index linked payments
Purchase or sale of contracts in foreign
currency (other than currency of major
party, or currency in which the contract is
normally denominated)
derivative if it was freestanding; and
The host contract is not carried at fair
value through profit or loss
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Accounting for embedded derivativesAccounting following separation:
Host: apply rules of AS 30 or other applicable standard if host is not a financial
instrument
Derivative: measure the separated derivative at fair value through profit or loss
Accounting when separation is difficult:
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If it is difficult to determine the fair value of the embedded derivative, it isdeemed to be the difference between the fair value of the combined (hybrid)
instrument and the fair value of the host contract
Accounting when impossible to separate:
If the embedded derivative cannot be reliably identified and measured, theentire combined contract is accounted for as a financial instrument at fair value
Separate accounting for option and non option embeddedderivatives
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Compulsory Convertible Debentures
To be considered as Equity since inception asissuer and holder have no option but to convert
Convertible Debentures
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nterest paya e, net o tax s to e treate asdividend
Optionally Convertible Debentures to separate
the value of option by computing value ofdebenture if it is redeemable at a fixed terms.
Same treatment for FCCB
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Objective of hedge accounting:
get the timing right
1 2 Cumul
Hedged item 0 (20) (20)
Hedging instrument 20 0 20
20 (20) 0
A
B
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A Accelerate recognition of gain or loss on hedged item (fair value hedge)
Defer recognition of gain or loss on hedging instrument (cash flow hedge)B
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Components of a hedge relationship
Hedged items
Hedgeable
risks
Hedging instruments
Hedging relationship components
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liability
- an unrecognised firm
commitment or highly
probable transaction
- net investment in non-
integral foreign
operation
than written options
- To hedge foreign
currency risk, non
derivative FA or FL can
be designated
- Instrument should be
with the external party
and not within the group
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Designation of Hedging Instruments To be designated in its entirety, except for time element
which can be separated
The full period of hedging instruments should be coveredi.e. if hedging instruments life is two years, one can not
hed e item with one ear maturit .
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A certain portion of hedging instruments, say 50% canbe designated.
It may cover more than one hedge item provided
the risk to be hedge is identified clearly
The effectiveness of the hedge can be demonstrated
It is possible to ensure specific designation.
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Hedge Items A group of assets or liabilities can be hedge items.
In a portfolio hedge of interest rate risk, a portion ofportfolio can be hedge item.
HTM investment can not be hedge item for interest rate
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r s , as s o e up o ma ur y. owever, can e
hedged item in respect of foreign currency or credit risk.
If the hedge item is a non financial asset / liability, itshould be for foreign currency risk or in its entirety for all
risks, as it is difficult to isolate and measure the cashflow or fair value changes attributable.
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Criteria for hedge accounting
Risk management objective and strategy for the hedge
Identification of the hedging instrument The related hedged item or transaction
The nature of the risk being hedged
How hedging instruments effectiveness will be assessed
1. Hedge relationship must be documented at inception
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2(a) Hedge relationship must be expected to be highly effective at inception andsubsequent periods
2(b) Hedge effectiveness can be reliably measured
3. In the case of hedging future cash flows, there must be a high probability
of that cash flow occurring
2(c) Actual hedge effectiveness must be measured
Firm commitments and forecast
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Firm commitments and forecast
transactions
Firm commitment definition:
A binding agreement for the exchange of a specified quantity of
resources at a specific price on a specified future date(s)
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orecas e ransac on e n on
A transaction that is expected to occur (highly probable) for which
there is not a firm commitment
Does not give an entity any present right to future benefits or a
present obligation for future sacrifices
Qualifying hedging instruments
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Qualifying hedging instruments
General rulesFew restrictions on use of derivatives as hedging instruments
Important exception: net written options
Natural hedges of FX risk permitted in limited circumstances
All of the derivative must be used in the hedge relationship
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Derivative cannot hedge another derivative
More than one derivative can be used in a hedging relationship
Profit related hedges not permitted
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Types of hedges
Fair value hedge Cash flow hedge Net investment hedge
Main types of hedging relationships
a recognised asset or attributable to a Hedge of a net investment
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liability;
an unrecognised firm
commitment; or
an identified portion
of any of the above
two, that isattributable to a
particular risk
part cu ar r s
associated with arecognised asset
or liability or a
highly probable
forecast
transaction; and
could affect profit
or loss
in a foreign operation
(including a hedge of amonetary item that is
accounted for as part of
the net investment as per
AS 13
Hedging instruments can
be foreign currency
monetary items or
derivatives
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Fair value hedge accounting modelMeasurement of derivative instrument
Fair value
Changes in FV
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Measurement of hedged item
Fair value with
respect to risk being
hedged(1)
P&L
(1) This applies even if a hedged item is otherwise measured at FV with FV changes recognised inequity or if hedged item is measured at cost
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Cash flow hedge accounting model
Fair value
Changes in FV
Equity
Measurement of derivative instrument
Effective
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P&L
(1)
(1) Based on timing of earnings impact of hedged item (cost of sales, depreciation, interest)
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Hedges of a net investment Not for parent stand alone financial statements, group financial
statements only
Must meet criteria for hedge accounting
Accounting treatment similar to that of cash flow hedges
45
same manner as the foreign currency translation gain or loss
Ineffective portion is recognised in the profit or loss
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Hedge effectiveness
General principles
Hedge effectiveness criteria
highly effective at inception
satisfy 80-125% effectiveness back test
Hedge relationship must be expected to be highly effective at inception and
in subsequent periods
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Different notional and principal
amounts for the derivative and
hedged item
Basis differentials
Different maturity and re-set
dates
Currency differences
Credit differences Inclusion of time value
125%
100%
80%
Hedge accounting; ineffectiveness in P&L
Hedge accounting; ineffectiveness in P&L
No hedge accounting
No hedge accounting
any ineffectiveness must be recognized in P&L even if hedgerelationship is effective
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When a hedge no longer is effective
If the ongoing highly effective criterion fails, hedgeaccounting is discontinued
Hedge activity recorded prior to loss of effectiveness is not affected.
The hedge does not qualify for special accounting prospectively
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.
There is therefore a trade off between performing effectiveness
testing frequently to ensure effectiveness and the administration
effort into doing this frequently
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Discontinuation of hedge accounting
Fair value hedges Cash flow hedges
Future changes in fair valueof hedging instrument
Continue to be taken to profit orloss
Recognised immediately inprofit or loss
Changes in fair value ofhedged item
Treat as if not hedged
N/A
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assets, adjustments to date is
amortized to profit or loss overthe period to maturity
Amounts recorded to datein equity:
a) hedged item still exist or still
expected to occur
b) hedged item or transaction
sold or no longer expected
to occur
N/A a) Transferred to profit or loss
at the same time as the
change in the hedged cash
flows is recognised in profitor loss
b) Transferred to profit or loss
immediately
T l t d i
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Tax related issues
1. Following should be allowed as a deduction in computing income
Amortization costs
Effect of adjustments to fair value
Impairment
2. Credit amounts to be transferred to equity not to be treated as income. Similarly
debit ad ustments to e uit should not be allowed as a deduction. In an case
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when the amounts are drawn from equity to P & L (at the time of transfer / sale
/ disposal) then the amounts will need to be considered in computing taxableincome
3. Effective interest rate / method concept needs to be aligned in Income Tax Act
4. Treatment of gains / losses on partial derecognition (transfers that do not
qualify for recognition or continued involvement in a transferred asset) needs tobe accepted by Tax Authorities
5. Accounting of Hedging as per AS 30 needs to be accepted by tax authorities
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THANK YOU
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???? Any Questions ???????? Any Questions ????